One of the many questions governments must answer when setting a price on carbon is how to allocate the potentially very large revenues that a cap-and-trade or carbon tax program would generate. RFF Darius Gaskins Senior Fellow Dallas Burtraw argues that two perspectives are emerging based on property rights: one views the atmosphere as property of the government, the other as a common-pool resource shared by its citizens. Resources sat down with Burtraw to discuss how this choice affects the efficiency and fairness of a given carbon-pricing program, and what these consequences mean for the political economy and likelihood of climate policy.
Resources: One of the first and most notable cases of using incentives to manage pollution in the United States was the regulation of sulfur dioxide emissions through a cap-and-trade program under the Clean Air Act Amendments of 1990. In that case, the emissions allowances were given to firms based on their historical levels of pollution. You’ve pointed out that using the same strategy for greenhouse gas regulation could have some very important distributional implications.
Dallas Burtraw: The situation for carbon dioxide is very different than it was for sulfur dioxide in 1990, because carbon dioxide is ubiquitous through our economy. If we have a system that gives emissions allowances for free to firms in a competitive economy, we can expect them to forward those costs to consumers through a change in product prices, just in the same way they would a change in their cost for fuel or labor. So it puts industry in a situation of being able to charge consumers for something they themselves have received for free. The consequence can be the prospect for “windfall” profits—that is, changes in revenues that are greater than the changes in costs that the firms actually have to incur in order to reduce their emissions. This has occurred already in Europe.
Resources: So when we create property rights in the environment and acknowledge this common property resource, are we actually creating a source of wealth?
Burtraw: I would make the observation that the introduction of a price on carbon in the US economy would constitute the greatest creation of a federally enforced property right since the opening of the Great American West in the nineteenth century. The land obviously existed previously and was inhabited by Native Americans, just as our atmosphere exists already, and we all breathe it.
Resources: You’ve identified two emerging paradigms for framing how we should treat this new wealth that’s created.
Burtraw: The two perspectives have to do with who receives this significant asset value. Is it inherently the property of government? That would justify using the revenue to address fiscal problems and other resources problems. Or is it inherently the property of individuals? In this case, compensation could take the form of dividends paid directly back to households.
These represent two different world views: One is that the resource is the domain of government, belongs to government, and should be managed by government. The other is that the atmosphere is the common property of individuals even though government plays a role in how to manage it.
Resources: This is no longer an abstract discussion. We’re seeing governments around the world employing carbon pricing and having to decide what they’ll do with the revenue. You and Samantha Sekar looked at six existing carbon-pricing programs in a recent paper: What are some of your insights?
Burtraw: What we see is a clear trend away from free allocation to industry and toward auctioning or direct introduction of emissions fees. This creates a large sum of revenue to be allocated. We find a variety of examples in the six programs of how the revenues are used, and we were able to quantify the results of the policies.
In some programs, investments are being made that complement the goals of the program—for instance, investments in energy efficiency. But we also see two extremes taking form in terms of the different philosophical perspectives I just mentioned. One approach is that the revenues are used as part of a tax swap, essentially helping to contribute to general revenue and address the fiscal challenges of the state. The other is that dividends are paid directly back to individuals.
The best examples of this latter approach come from California, British Columbia, and Australia. Under California’s cap-and-trade program, nearly half the revenue that’s being collected in 2013 will be returned to individuals as dividends. In British Columbia, about 20 percent of the revenue collected under their carbon tax is returned as dividends to households. And in the Australian carbon tax program—which just began to take shape and now is in limbo because the country has just voted in a new prime minister—about 70 percent of revenues would be returned to households as dividends.
Resources: How does the way we use the money from these kinds of programs affect the overall economic efficiency of the programs?
Burtraw: The major lesson from public finance in looking at how we might introduce a price on carbon is that using the revenues to reduce distortionary taxes can lower the overall cost of the program. If you use the revenue created by introducing a price on carbon dioxide to reduce preexisting taxes, you can then essentially get a bounceback in economic growth and stimulate the economy. So that’s one reason why a public finance economist will suggest a tax swap. Introducing a tax on dirty goods, such as carbon dioxide, and using the revenue to offset preexisting taxes on things that we want to see—like more labor and more capital investment—can be good for the economy.
Resources: It’s interesting to see how this will play out because, even leaving aside the ethical and philosophical questions, these approaches play into questions of political economy.
Burtraw: That’s exactly the point the proponents of a dividend approach embrace—the notion that it’s politically reinforcing to give dividends because it has the prospect of making climate policy popular. People may not like to pay more for gas at the pump or more in their electricity bill, but it appears from the social science literature that getting checks back in the mail is what really lingers with us. People really look forward to that dividend as a special windfall in its own right.
But the other problem we face is that carbon is a ubiquitous pollutant in our society, and to address the challenges of climate change, it’s going to be a very expensive venture. We’re going to need to find a way to do it that poses the least cost on our economy and helps the economy to grow—because to the extent that the economy grows, that’s good for everyone. The efficiency benefits of using revenues to reduce preexisting taxes can be substantial compared to other approaches.
This frames a central dilemma in having to choose between two options that each have their downsides. The more efficient approach of using revenues to reduce preexisting taxes may be perceived to have unfair distributional outcomes. A dividend approach, which seems eminently more fair, may have large efficiency costs compared to the alternative.
Resources: Another point you touch on in the paper is that carbon is a global pollutant—and it’s also a stock pollutant. Particularly when you have a situation where the stock has been added to by developed countries, is there an ethical property right case to be made that the revenue should be recycled to countries outside the developed world on a per capita basis?
Burtraw: You can take the reasoning of introducing dividends in the domestic economy and say, “Shouldn’t that apply internationally? Shouldn’t everybody get an equal share of the atmosphere?” There’s strength to that logic, but I think it’s undermined by the fact that different parts of the world exist under different property rights regimes, and many parts of the developing world have not bought into a climate policy regime under which they take on obligations for reducing their own carbon emissions. So in the absence of a legal framework for shared property rights, I think it’s unreasonable to make the leap from using dividends in the domestic economy to using dividends on an international basis. But somewhere down the road, under optimistic scenarios about international agreements, that conversation may be had.
Burtraw, Dallas, and Samantha Sekar. 2013. Two World Views on Carbon Revenues. Discussion paper 13-32. Washington, DC: RFF.